As of 2015, the IRS allows taxpayers to exclude up to $250,000 (or $500,000 for married couples) of capital gains from the sale of their primary residences. However, taxpayers do have to pay taxes on any gain that exceeds the limit. Taxpayers also have to pay capital gains if they sell other real estate, like rental property, or other personal assets, such as cars and household furnishings, at a gain. Any improvements you made will decrease your capital gain, though they are not technically called deductions.
It's important to distinguish between home improvements and maintenance costs. Improvements will decrease your capital gain while maintenance costs will not. According to the IRS, a home improvement is any expense that increases the value of your home, restores structural damage, adapts the use of the home or prolongs its life. Some of the most common improvements the IRS allows are:
- Adding a new bedroom, bathroom, garage or porch.
- Installing a new roof, security system, wiring or better windows and doors.
- Installing a new plumbing, heating or cooling system.
- Constructing a pool, driveway, retaining wall or doing significant landscaping.
On the other hand, home repairs or yard maintenance are not considered improvements.
Improvements and Your Basis
Although you can't technically deduct improvements, they do reduce the amount of your capital gain. Improvements reduce your taxes because they increase your basis in the property. Capital gains are the excess of sales price over your basis, so a higher basis means a smaller gain.
To calculate basis, sum all of the costs you incurred to purchase and improve the home. Say that you purchased your home for $100,000 and paid $5,000 in closing costs. Over the course of 10 years, you paid $30,000 to improve the home. Your basis is $100,000 plus $5,000 plus $30,000, or $135,000. If you sold your home for $600,000, your capital gain would be $600,000 less your $135,000 basis, or $465,000.
In addition to adjusting your basis, you can also deduct selling expenses from the capital gain on your home. For example, Ii you incurred $5,000 worth of selling expenses to sell your home, a $465,000 capital gain would be reduced to $460,000.
Potential selling costs include advertising, appraisal, attorney fees, commissions, escrow fees, notary fees and closing costs. Nolo.com notes that many of these expenses will be listed on the closing statement when you sell the home.